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Just in Time (JIT) Method - Overview, Pro/Con, Example (corporatefinanceinstitute.com)

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Definition and explanation

Just-in-time (JIT) is a management approach that is used to control the flow of inventory to and from a business in order to minimize inventory levels and to improve the efficiency of the manufacturing processes.

The strategy is to arrange the orders of raw materials in such a way that the goods are only ordered when required for production. This is achieved by aligning the orders placed by the customers with the orders placed for the raw material. So, the implementation of Just in time approach makes the level of raw material that will be used and the level of inventory that would be available in the company at a specified time.

The primary focus of the technique is to reduce the time taken between the placing of the order by a company for raw materials and delivering the finished goods to the customers. Therefore a company only buys its raw material when it needs to commence production. This reduces the 'lead time' for the company and the holding costs, simultaneously the losses of inventory are significantly minimized which varies based upon the nature of business.

Application of just in time theory:

The theory of Just-in-time is a 'Japanese Management Philosophy'. It was first adopted by 'Toyota Manufacturing Plants' in the early 1970's. Toyota had to improve their internal systems and external relations with their suppliers and customers to implement the strategy. Because, management of Toyota Company realized that in order to apply JIT effectively, they have to keenly focus on the training and commitment of their employees and enhancement of their systems to their full capacity.

The main limitations that Japanese auto mobile industry especially Toyota tried to overcome by using JIT were that Japanese companies could not produce their products in batches as the size of their industry was very small and had less 'economies of scale'. Additionally there was no appropriate policy of pricing present due to which it was inevitable to reduce their manufacturing costs.

Now-a-days there are a number of companies that are using just-in-time in their businesses or specific segments of business in order to improve their operational and productive efficiency. One of the examples is McDonalds, an American chain of restaurants which is spread in almost whole of the world. McDonalds implemented JIT in their systems to face the difficulties related to obsolescence of their raw food in restaurants as well as the time required to fulfill an order. The business introduced sophisticated methods of making burger. They shifted to use of frozen food and only completed an order after it was placed and money was received.

McDonalds also had to redesign its procurement function. By making this function centralized each branch of their restaurant was supplied the raw food products based on their specific demand.This approach successfully reduced the cost that McDonalds bore by minimizing the restaurant inventory. Additionally, the customer service and quality of food was also enhanced as the food (usually burgers) are prepared fresh and in minimal time (reduced from 11 minutes per order to 1.5 minutes per order).

Advantages and disadvantages of just in time system

The major advantages and disadvantages of just in time manufacturing and inventory control system are given below:

Advantages:

Due to a continuous flow of raw materials and inventory the space needed to store these goods reduces. This would mean that the business will not have to buy or lease any large stores or warehouses in order to hold these goods (raw material or/and inventory) unlike the traditional inventory control systems where a certain level of raw materials, work-in-progress and finished goods is maintained. This would decrease the holding cost of the company.

The chances of losses of inventory (normal and abnormal), wastage or damage of raw materials and the obsolescence of these goods minimizes. This prevents the capital invested in raw materials and inventory from becoming a sunk cost of the business.

In order to maintain an efficacious just-in-time system the business needs to improve its overall processes and make its human resource more competent. So, by implementing JIT the overall performance of a business enhances.

The technique is easy to understand by the management of a company. This makes it practical not only for large companies but also for small and/or medium sized entities to implement just-in-time. Additionally, the capital needed to be invested in such systems is less so JIT approach is economically viable for small businesses in this sense.

By increasing the operational efficiency of the company it provides the management a chance to improve other areas of business too. One of the most important areas being the 'costumer satisfaction'. As in 'just-in-time' each order is produced specific to each costumer so, it provides a chance for enhanced customization in every order thus more space to meet the requirements of the costumers.

Disadvantages:

The notable disadvantages of implementing a just in time system are given below:

Although the idea of this technique is easy to understand but it may become difficult to implement in many circumstances. This is majorly because there are no hard and fast rules to follow in JIT approach and each business has to implement it based on its own weaknesses and strengths.

In order to effectuate just-in-time proficiently, a business needs a very strong supply chain. The reason being, if any of the link in the supply chain i.e. suppliers, manufacture, labor etc. breaks down, it can disrupt the whole production line and could lead to order delays.

The forecasting of the demand of produced finished goods is difficult. The businesses not only need to forecast the costumers demand but also have to arrange suppliers of raw materials based on their estimated demand. This could create problems if a huge change in demand occur.

A business need reliable suppliers to sustain JIT approach. These suppliers must meet the deadlines to supply raw materials which is very important in order to fulfill the orders promptly. Additionally, the goods provided by the suppliers must also meet the quality requirements because if the products are faulty or defective, it could lead to delays in production and an increase in losses of raw material and revenues.

It becomes difficult for businesses that adopt just-in-time technique to maintain the required number of employees required. As the employees are only required to work when an order is placed by the costumer, businesses usually have to employee both permanent and temporary labor based on their needs and market demand.

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Just in time - definition, explanation, advantages and disadvantages | Accounting For Management

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Definition and explanation Just-in-time (JIT) is a management approach that is used to control the flow of inventory to and from a business in order to minimize inventory levels and to improve the efficiency of the manufacturing processes. The strategy is to arrange the orders of raw materials in such a way that the goods [...]

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What is the Theory of Constraints

Theory of Constraints (TOC), a process improvement approach that aims to improve the performance and profitability of any system by identifying and eliminating the "constraint" that limits its output, throughput, and goal achievement.

Dr Eliyahu Goldratt[1], an Israeli physicist turned management guru, conceived the Theory of Constraints and introduced it through his bestselling 1984 novel, "The Goal".[2] Since then, TOC has continued to evolve and develop and is today a well-known management best practice.

Why use Theory of Constraints

An independent study on the application of the Theory of Constraints (TOC) in various companies yielded the below findings:[3]

Over the years, the principles of TOC have proven instrumental in enabling organizations to achieve profitability through enhanced performance, strategic market positioning, robust financials, proactive problem-solving (rather than firefighting), improved customer service, prevention of conflicts and more.

TOC principles have been used in a wide range of industries and domains from manufacturing to software development to project management to healthcare.

The Goal in Theory of Constraints

To identify constraints in any system, it is important to define what an organization intends to achieve. This raises the question - what is the goal of an organization?

According to TOC, the one and only goal of any for-profit organization is to make money.

In a plethora of conflicting objectives and operational targets, the relationship between actions taken on the ground versus the money it generates for the organization is often lost or is vague at best. Hundreds of key performance indicators (KPIs) make it difficult for organizations to focus on what is important.

TOC addresses this problem by defining the Goal in terms of just three key measurements - Throughput, Inventory and Operational expense.

Throughput
The rate at which the system generates money through sales.

Inventory
The money that the system has invested in purchasing things that it intends to sell.

Operational expense
The money the system spends in order to turn inventory into throughput.

The goal of an organization is to increase throughput while simultaneously reducing both inventory and operating expenses.

By evaluating an organization's objective through the Theory of Constraints (TOC) framework, clarity arises as to whether it contributes to the organization's overarching goal of generating profits.

Everything within an organization fits within the three parameters - Throughput, Inventory and Operational Expense.

For example, a decision to install a machine will lead to higher depreciation costs, which is an operational expense. The current value of that machine is inventory. If the machine improves throughput over and above the burden on inventory and expense, it contributes to the organization's overall goal.

Similarly, if an organization's (or a department's) objective is to improve productivity, any action that moves it towards making money is productive and an action that takes it away from making money is non-productive.

Constraint in Theory of Constraints

A constraint is what "limits a system from achieving higher performance versus its goal".

For any organization, throughput measures the flow of goods and services to market and a constraint is that which limits the maximum possible flow. In other words, the constraint is what, if the organization had just a little more, would generate higher Throughput.

When driving continuous improvement, organizations are tempted to try to improve everything at once, but it rarely leads to sustained improvement in the overall performance of the organization.

This is because not all improvements are created equal. Only a few improvements/changes impact the constraint and improve throughput while most do not. This seemingly minor distinction makes all the difference.

Example of a Constraint

To demonstrate this concept, consider an automobile manufacturing company whose manufacturing process consists of 5 stage, as depicted in the figure below:

The five stages are - frame manufacturing, engine installation, parts assembly, painting, and shipping. Maximum capacities per day are indicated under each activity.

It can be seen from the figure that the paint shop has the lowest capacity of 75 cars per day. Going by the definition of constraint, this is the current limiting factor for the maximum number of cars that the company can produce.

Suppose the engine installation department decides to invest $15,000 in a new robotic arm that improves the capacity by an additional 25 cars per day. As seen from the figure above, the engine installation capacity would increase from the current 125 per day to 150 per day.

Would this change the throughput?

Unfortunately, this would have no impact on the painting process and hence, the throughput would remain unchanged. Such a move would not benefit the company.

Suppose that the company decides to install an additional Painting bay to double the capacity from 75 per day to 150 per day. With this, the constraint will shift to engine installation. With this, the company can manufacture 125 cars instead of 75 cars.

Investing in that robotic arm will now improve throughput. But there is a catch. Notice how the next constraint in the system becomes the parts assembly that limits the production to 135 per day.

The benefit of increased engine capacity will be realized to the extent of an additional 10 cars per day before the constraint shifts to the Parts Assembly which then limits the throughput to 135 cars per day.

In most systems, there is one constraint at a time that limits it from advancing towards its Goal. The central message of TOC is to identify and address such constraints one at a time to improve throughput.

And any improvement in throughput takes the company that much closer to its Goal.

Constraint vs. Bottleneck

A bottleneck is a resource whose capacity is less than or equal to the demand while a constraint is a limiting factor to an organization's performance. It is the current obstacle to the organization achieving its goal.

A constraint can be called a bottleneck, but a bottleneck is not always a constraint.

Consider the example of the automobile manufacturing company above. Having upgraded the paint and assuming a market demand of 140 cars per day, the constraints and bottlenecks for the company will be as below:[4]

Notice how the parts assembly process is not currently a constraint but still a bottleneck. If the engine bay can produce more than 135 cars, the constraint will shift to the next bottleneck, i.e. Parts assembly.

Alternatively, if the market demand itself would be 130 cars per day (instead of 140), then the Engine bay would be the only constraint as well as the bottleneck.

Can there be Multiple Constraints?

In real-world scenarios, processes are far more complicated and involve thousands of sequential as well as non-sequential sub-processes that come together to form the final product (or service).

Such systems could sometimes have more than one constraint but in most cases, current constraints are only a handful.

It is important to note that Every independent path of flow will have its own constraint, but the system (as a whole) will still have one (or two) constraint(s) as the limiting factor to the overall flow.

TOC encourages focusing on one or two constraints at a time and exploiting them to improve throughput.

Types of Constraints

Constraints can be both internal and external to the organization.

They can also be classified as Equipment-based (where the way equipment is used limits the system's ability), People-based (lack of skills or wrong knowledge and beliefs), and Policy-based (written or unwritten policies that prevent the system from making more).

Examples of some of the constraints are as below:

Capacity Constraint (internal): This is when the current ability to deliver is less than the market demand for those products or services.

Like in the example above, a company in this situation typically has a backlog of sales orders, low delivery performance, and/or stockouts. By the principle of TOC, the real test of an internal capacity constraint is very high utilization of at least one internal resource (95%+).

Cash Constraint (internal): This is when a company's ability to source inputs is less than market demand due to the inability to pay suppliers. This situation can also be triggered when suppliers blacklist an organization due to late payments and/or disputes may have been taken to court.

Suppliers typically expect upfront payments in such cases and a small increase in cash usually can increase sales, throughput, on-time delivery and available cash in a relatively short amount of time.

Regulations and Standards (internal/external): Regulations and standards can limit a system's time and level of use. These can be quotas, schedules, or mandatory. For example, reducing the speed of a machine between 22:00 hrs. to 06:00 hrs. to control noise levels.

Demand Constraint (external): This is where the market demand at current prices is less than the rate at which a company could produce the product or service.

When a company begins eliminating its internal constraints, they shift and eventually, the supply outnumbers the orders that the company could secure. In such a situation, all backlog orders are fulfilled, and production is limited by the number of orders.

Though this is an external constraint, it can be addressed through focused marketing efforts or providing bulk discounts if the economics works out.

Market Constraint (external): this is where a company captures the bulk of the market and runs out of further space to grow.

For example, Google Search occupies almost 90% of the search engine market share and has limited potential to increase its user base significantly. Unless the market itself expands, there is little chance that it could double its user base in a short span as it did very easily in its growth years.

Supply Constraint (external): This is when a company is unable to meet all its demand due to shortages in input materials/services. For example, chip shortages triggered during the pandemic impacted almost every company in the automobile and electronics sector.[3]

Dependent Events, Statistical Fluctuations & the Origin of Constraints

A balanced plant is an ideal system where the capacity of all resources is trimmed to exactly match the market demand. In such a system, every resource works to its full capacity and is optimally utilized. There are no constraints in such a system, which operates at peak efficiency with zero wastage.

The only problem is that such a plant does not exist.

Two factors make it difficult to achieve such a balance. Dependent Events and Statistical Fluctuations.

In any plant process, an event, or a series of events, must take place before another can begin. The subsequent event depends upon the ones before it. This is called a dependent event.

Likewise, in these processes, some types of information can be determined precisely while others cannot. These types of information vary from one instance to the next and are subject to statistical fluctuations.

For example, it's possible to predict whether a computer-controlled robot will complete an assembly in precisely 56 seconds, but it is not possible to predict if a truck will arrive at the loading bay precisely at 9:15 AM.

When companies operate complex processes with thousands of variables, most of the factors critical to running them successfully cannot be determined precisely ahead of time. When a fluctuation occurs in one of the sub-processes, a constraint is created.

The Five Focusing Steps of Theory of Constraints

The Theory of Constraints proposes a five-step process to improve efficiency and achieve higher throughput. While originally applied to the manufacturing process, these steps today are used in a wide range of industries, from production to finance to healthcare. They are depicted in the figure below:

Step 1: Identify the constraint

In any system, a constraint always exists, or else production would be infinite. Identifying a constraint begins with the research of the bottlenecks - the weak links in the system.

Production bottlenecks are generally known and easy to identify. If not, a good way to find would be to spot signs of inventory pileup upstream where parts wait to get processed. Similarly downstream, resources are under-utilized as they wait for parts to arrive through the constraint.

Non-production bottlenecks are a bit tricky to locate. They could range from bad planning to poor skills to an engineering practice that is followed but not actually needed etc. These can be identified using the TOC thinking processes discussed later in this article.

Step 2: Exploit the constraint

To exploit a system's constraint is to make sure the constraint is fully utilized. This step aims to identify the factors that negatively impact the constraint's workflow and eliminate/mitigate their impact.

The figure above shows typical losses for a production line resource. If this resource were to be a constraint, then exploiting the resource, in this case, would mean:

Adjusting the schedule for a 24-hour operation.

Minimizing downtime through preventive maintenance, maintaining a buffer stock of spare and tools, and scheduling maintenance during changeover/loading.

Optimizing the machine's performance to operate close to its maximum capacity, including determining the optimal batch size and appropriate loading techniques.

Implementing rigorous quality control measures to identify errors in input materials, with a focus on upstream quality control rather than downstream.

In this step, any potential inefficiencies related to uptime and productivity must be eliminated as they directly impact the company's overall productivity.

On the contrary, if the resource is not a constraint, the principles of the TOC suggest a different approach. In such cases, it is advisable to allow the resource to remain idle or underutilized which brings us to Step 3.

Step 3: Subordinate everything else to the Constraint
The idea is to avoid local optimization and focus on constraint optimization.
A constraint cannot be exploited (Step 2) in insolation as processes operate in "chains". Any changes made to a constraint located mid-process will have an impact on the previous as well as the subsequent processes.

Such impact could be in the form of slowing down/speeding up downstream processes, producing more at some stations while less at another, or making changes to the number of intermediate parts which are buffer inventory.

Often, this can mean higher costs/time in operating some of the non-constraint processes. To subordinate a constraint implies making such modifications despite them appearing suboptimal at a local level.

TOC provides an effective tool to manage this process called the Drum-Buffer-Rope (DBR).

DBR originated in Goldratt's first book "The Goal"[2], but got its name later in his book "The Race".[5]

DBR is a constraint-aware workflow control process in which the "drum" beat sets the pace of production based on the constraint's capacity, the "buffer" provides a contingency, and the "rope" controls the flow of work.

In the manufacturing example (figure above), the drum is the bottleneck, i.e. Station-3 which has the lowest capacity of 75 parts/day. This also governs the system's throughput.

The buffer is the material upstream of the constraint, which is to make sure the drum is never starved. This is to address any fluctuations in previous stations.

The rope is a signal or information from the buffer to the beginning of the line (Station-1). If the drum processes parts, the parts in the buffer move forward. The rope then sends information to replenish another part at the beginning of the line.

Notice how stations 1 & 2, which have capacities higher than the constraint, will be under-utilized. The central idea of Step-3 (subordinating everything else) is to let this happen as it does not impact the throughput.

If stations 1 & 2 were allowed to run at full capacity, the corresponding accumulation of inventory (before station 3) would increase expenses without improving throughout - a move that would take the process away from its Goal.

Step 4: Elevate the Constraint

In this step, more substantive changes are implemented to break the constraint. These steps might involve a significant investment of time and/or money.

The key action in this step is to weigh the impact of additional investments like bringing in a new resource or major process modifications using the throughput accounting metrics (throughput/inventory/ operational expense) and implement them to improve the throughput.

Step 5: Find the next constraint (Back to step 1)

When constraints are elevated (Step-4), they cease to be bottlenecks, allowing attention to shift toward the next limiting factor in the process - the new Constraint.

This necessitates a return to Step-1 until the new constraint is optimized. Eventually, the constraint may shift towards external factors such as market demand. In such cases, the company can address this by concentrating on cost-reduction strategies to enhance competitiveness or by intensifying marketing efforts.
Problem Diagnosis -> Designing a Treatment Plan -> Executing the Treatment Plan
This is the TOC's ongoing process for continuous improvement.
What to Change? What to Change To? How to Cause the Change?
The Theory of Constraints Thinking Process

TOC applies the cause-and-effect thinking processes used in the hard sciences to understand and improve organizations. The process is analogous to a clinician treating a patient as follows:

In the language of organization problem-solving, the process is described via the use of three questions:

TOC also provides six logical steps that are embedded into these questions and aid in effective organizational problem-solving as discussed below:[3]

What to Change?
The process involves two steps:
From a list of observable symptoms, cause-and-effect is used to identify the underlying common cause, the core problem, for all the symptoms.

In organizations, the core problem is inevitably an unresolved conflict that keeps the organization trapped and/or distracted in a constant tug-of-war (management versus market, short-term versus long-term, centralize versus decentralize, process versus results). This conflict is called a Core Conflict.

Due to the destructive impact of Core Conflicts, organizations often devise policies, measures, and behaviors to mitigate their adverse effects. When addressing the Core Conflict, these approaches must be eliminated, altered, or substituted.

Step 1: Identify the Core Conflict causing the symptoms, or UnDesireable Effects (UDEs), of the chosen subject.

Step 2: Build a Current Reality Tree (CRT)[8] that validates the identification of the Core Conflict. This helps understand the existing cause-and-effect relationships of the subject and identifies the conspiring formal and informal policies, measurements and behaviors that support the existence of the UDEs.

What to Change To?

By challenging the logical assumptions behind the Core Conflict, a solution to the Core Conflict is identified in this step.

Step 3: An Evaporating Cloud (EC)[9] (Also called Core Conflict Cloud) must be constructed to articulate the core conflict clearly. This helps surface hidden assumptions so that some of them can be invalidated.

This is only the starting point for the development of a complete solution - a strategy for resolving all the initial symptoms and many others, once and for all.

The strategy must also include the changes that must be made alongside the solution to the Core Conflict to ensure that the solution works and that the organization is restored to its "best possible health."

Resolves all the UDEs

Ensures alignment with the Strategic Objectives (SO)

Ensures that no new negative side effects (Negative Branches) will occur

Identifies what changes in the culture of the system and/or sub-system must be made to ensure the symptoms are resolved

Leverages the existing TOC applications needed to make the solution/ strategy work

Quantifies the "bottom line" value of achieving those desired effects and SOs

These often involve changes to the policies, measurements, and behaviors identified in "What to Change?", as well as the organization's strategic objectives.

The strategy is not complete until all potential negative side-effects of the strategy have been identified and the means for preventing or mitigating them become key elements of the strategy.

Step 4: Construct a Future Reality Tree (FRT)[10] that lays out the complete solution/strategy that:

FRT maps the full implications of the proposed injections (actions that solve the conflict) to ensure that they are sufficient to solve every UDE.

How to Cause the Change?

Considering the unique culture within organizations, a transition plan is developed in this step. This helps move the organization towards strategy realization.

This plan must specify necessary actions, responsible parties, and timelines and must chart the overall course for getting from the Current Reality to the Future Reality.

Step 5: Construct a PreRequisite Tree (PRT)[11]

Details of what each part of the system/sub-system must contribute and when to achieve each of the milestones must be mapped using a PRT.

A PRT takes the complete set of injections (solution elements) from the FRT and sets them as its "objectives." It then breaks these objectives down into an ordered sequence of intermediate objectives (key milestones) for execution.

Step 6: The last step is to create a detailed task interdependency diagram using Transition Trees (TRTs). A Transition Tree is a step-by-step sequential depiction of how to implement the change. TRTs combine an entity of current reality, a statement of need and an action (injection) to create a new reality (expected effect).

Thus, the three questions-What to Change? What to Change To? and How to Cause the Change?-alongside the Six steps, together form the framework known as the TOC Thinking Process.

Six Layers of Resistance to Change

Building active consensus, collaboration and buy-in is crucial for the success of a plan.

To address this, TOC has developed a process based on the psychology of change that acknowledges and systematically addresses the questions people intuitively ask when evaluating a change.

They are:

If these questions aren't answered frankly and effectively (with both the people who must implement and those who will be affected by the change), there will be no buy-in and support. Like most changes, no matter how great the idea or tremendous the value, the strategy and tactics are bound to fail.

The Nine Rules of Theory of Constraint

Before developing the Theory of Constraint, Goldratt, along with other Israeli researchers worked on a theory called Optimized Production Technology (OPT). Developed in the 1970s, OPT is a production management methodology that helps organizations achieve greater profitability and less waste.[7]

TOC has been shaped by the nine rules of OPT that are essential to adapt the TOC mindset. They are:

1. Balance flow, not capacity

By balancing the flow of the products with the market demand, constraints can be eliminated while avoiding excess capacity.

2. An hour lost at a bottleneck is an hour lost for the total system

A bottleneck with no reserve capacity (constraint) governs the system's throughput. Any loss here is critical and irreversible.

3. An hour saved at a non-bottleneck is just a mirage

The flow remains dependent on the bottleneck. An hour earned on a non-bottleneck does not benefit the system's throughput but will only increase the inventory.

4. The level of utilization of a non-bottleneck is determined not by its own potential but by some other constraint in the system

By applying the principle of the DBR, non-bottleneck resources must be controlled by the bottleneck. Using non-bottlenecks according to their capacity would only produce excess inventory.

5. Utilization and activation of a resource are not the same

"Utilizing'' a resource means making use of the resource in a way that moves the system toward the goal. "Activating'' a resource is like pressing the ON switch of a machine; it runs whether or not there is any benefit to be derived from the work it's doing.

6. Bottlenecks govern both the throughput and inventory in the system

The overall throughput of the system cannot exceed the amount of the constraint. The blind activation of upstream resources can quickly inflate inventories.

7. The transfer batch may not and often should not be equal to the process batch

The transfer batch, which refers to the number of items moved between process stages, is typically not required to be the same as the process batch size. They can differ due to various factors and considerations to optimize the overall efficiency and effectiveness of the system.

8. The process batch should be variable, not fixed

The process batch, referring to the number of items processed together, should ideally be flexible and adaptable rather than rigidly fixed. This variability allows for better responsiveness to changing conditions, improved efficiency, and optimization of resources based on the specific requirements and constraints of the system.

9. Capacity and priority should be considered simultaneously, not sequentially

By considering them simultaneously, decision-makers can optimize resource allocation based on both the available capacity and the relative importance or urgency of tasks, leading to more effective and efficient utilization of resources within the system.

Throughput Accounting and True Cost of a Constraint

TOC's Throughput Accounting is an alternative accounting methodology that attempts to eliminate harmful distortions introduced by traditional accounting practices - distortions that promote behaviors contrary to the goal of increasing profit in the long term.

Inventory: traditional accounting treats inventory as an asset, assuming it can be sold for cash. This can lead to producing unnecessary items which inflate assets and generate "paper profit" based on unsellable inventory that also incurs storage costs.

In contrast, the Theory of Constraints views inventory as a liability, as it ties up cash that could be better utilized elsewhere.

Expense: traditional accounting prioritizes expense reduction, while the Theory of Constraints values increasing throughput over cutting expenses. Expense reduction is limited by reaching zero expenses, whereas increasing throughput has no such limitations.

When eliminating constraints, companies encounter situations where expensive or less efficient alternatives could increase throughput. But in such cases, decisions are driven by isolated cost considerations or local optima rather than throughput. This could be counterproductive.

Consider the example in the figure below that illustrates a chain installation bay involving two machines. Assume that the bay is a constraint in the factory. The chain can be installed either by utilizing a cost-effective and efficient machine (Machine-1) only or by also simultaneously utilizing a more expensive and slower machine (Machine-2).

As the process is a constraint, there is a queue of bulldozers (inventory) waiting to complete this process.
Scenario 1: Using only the fast and efficient machine: Scenario 2: Augment capacity using the slower and less efficient machine:
An assembly of a bulldozer where the chain installation process is a constraint

If one looks at the process in isolation, it becomes clear that Machine-2 is both expensive to run and slow, thereby it is ideal to process the load on Machine-1. If the installation bay manager were to make a decision, he/she might choose to reduce costs by using only Machine-1 (cost control is an important KPI for individuals and departments).

It is only when the situation is analyzed using the principles of TOC, the true cost emerges.

In the second scenario, the company can ship five additional bulldozers per day making an additional revenue of $500,000 and a profit of $50,000 by spending $ 10,000. This takes the company closer to its Goal vs the first scenario of running a single machine.

While unit economics drive decisions in most companies, the goal-optimized process flow in TOC demonstrates how constraint elimination can have a huge impact on the Revenue and Profitability of a company.

Conclusion

In Conclusion, the Theory of Constraints is a powerful management philosophy that helps organizations achieve their goals by focusing on the most critical factor that limits their performance.

It provides a set of tools and methods for identifying and eliminating constraints, analyzing, and resolving problems, measuring, and improving performance, and developing and communicating strategies.

While TOC has helped organizations improve productivity, quality, customer satisfaction, profitability and more, its principles can be equally beneficial when applied to individual problem-solving endeavors.

Sources

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2. "The Goal". Wikipedia, https://en.wikipedia.org/wiki/The_Goal_(novel). Accessed 21 Jun 2023

3. "The Theory of Constraints and its Thinking Processes". Everydaykanban, https://www.everydaykanban.com/wp-content/uploads/2013/05/the_theory_of_constraints_and_its_thinking_processes.pdf. Accessed 23 Jun 2023

4. "Constraint vs. bottleneck". CHRIS HOHMANN, https://hohmannchris.wordpress.com/2014/05/06/constraint-vs-bottleneck/. Accessed 22 Jun 2023

5. "Shortage of Legacy Chips Keeping Ford CEO Up at Night". Bloomberg, https://www.bloomberg.com/news/articles/2022-11-18/shortage-of-legacy-chips-keeping-ford-ceo-up-at-night. Accessed 22 Jun 2023

6. "The Race". ISBN, https://isbnsearch.org/isbn/9780884270621. Accessed 23 Jun 2023

7. "A Critical Look at Goldratt's Drum-Buffer-Rope Method". Christoph Roser (Allaboutlean.com), https://www.allaboutlean.com/drum-buffer-rope/. Accessed 23 Jun 2023

8. "Current reality tree (theory of constraints)". Wikipedia, https://en.wikipedia.org/wiki/Current_reality_tree_(theory_of_constraints). Accessed 23 Jun 2023

9. "Evaporating Cloud". Wikipedia, https://en.wikipedia.org/wiki/Evaporating_Cloud. Accessed 24 Jun 2023

10. "What is Future Reality Tree?". visual-paradigm.com, https://online.visual-paradigm.com/knowledge/problem-solving/what-is-future-reality-tree/. Accessed 23 Jun 2023

11. "Prerequisite Tree (PRT)". Tocinstitute.org, https://www.tocinstitute.org/prerequisite-tree.html. Accessed 24 Jun 2023

12. "Thinking Processes - Transition Tree". CHRIS HOHMANN, https://hohmannchris.wordpress.com/2015/07/13/thinking-processes-transition-tree/. Accessed 24 Jun 2023

13. "Learn how OPT acts in process optimization by identifying production bottlenecks". Thinkleansixsigma, https://www.thinkleansixsigma.com/article/opt-what-is-and-how-it-works. Accessed 23 Jun 2023

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Theory of Constraints (TOC): All You Need to Know - SM Insight

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An in-depth guide to the Theory of Constraints (TOC), a process improvement approach aiming to improve the performance of any system.

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Porter’s Value Chain Model, Definition, Examples, and Use Cases

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Learn how Porter’s Value Chain Model helps businesses identify competitive advantages, reduce costs, and create value for customers. Explore examples and see how it complements other Porter frameworks.

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Introduction

The four levers of control were developed by Robert Simons in the 1990s from his study of practice. The four levers comprise:

Diagnostic control

Interactive Control

Boundary Systems

Belief Systems

Diagnostic Control

Diagnostic control is the standard use of performance measures and is primary focused on Feedback control. Performance is measured against a target and management acts on the variance. Diagnostic control also means that performance is regularly reviewed in formal meetings such as board, departmental and team meetings on a regular basis.

Interactive Control

Interactive control is completely different. This is an approach senior managers use to create meaningful and purposeful conversations right across the company and to interact at all levels. Typically, companies take just one issue which they subject to interactive control. One of the examples used by Simons was Pepsi's focus on market share against Coca-Cola in the US. Pepsi's objective was to overtake Coca-Cola's market share, so this was the measure used in every review meeting and every conversation. Senior managers could ask at any level in the organisation, what was happening about the market share, how that compared to Coca-Cola and why the changes (good or bad) were happening?

The benefit of using interactive control in this way is that it creates real focus on a single issue. That doesn't mean other issues are ignored (there are diagnostic controls to look after those) but one issue is singled out for special attention. It also means the senior executives speak with a single voice, they can't all have their own pet issue. Further, it is a conduit for feedback and learning, through the continuous questioning around why performance is or is not improving on this measure.

The four key elements that make control interactive are:

A recurring theme on the agenda at the highest level of management,

that requires regular attention from middle management, which is

interpreted and discussed in face to face meetings and conversations and

subject to continuous challenge and debate of the data, assumptions and action plans.

Boundary Systems

Boundary systems are a statement of what the company is not going to do. This may seem counter intuitive, but it is a mechanism for focusing the organisation and ensuring people don't spend time investigating and developing new opportunities that the company is never going to pursue.

One example given was Bill Gates statement of what Microsoft was not going to be. They weren't going into hardware and computers, they weren't going to go into telephone networks or consulting and software integration.

There is also the story of IBM and EDS. IBM was developing their world wide consulting offering. Ross Perot was a top salesman but wanted IBM to create a facilities division. Facilities management was not a consulting offering in IBMs view of the world and through this boundary condition he was prevented from pursuing his idea. Ross Perot eventually left IBM to start Electronic Data Services (EDS), which went from strength to strength. There was then the apocryphal meeting when the chairman of IBM met Ross Perot by chance in a restaurant and asked him if he had realised at the time how big the facilities market was going to be for EDS. Apparently Ross Perot said that he didn't but that it was big enough for him to see a good business opportunity for his new company.

So Boundary Controls are a two edge sword. They do stop people wasting time by constraining the opportunities they explore, but if they are badly drafted or nor reviewed, they can prevent the creation of new growth areas for the business.

Consequently, you need to take time to think through your boundary controls before you state them as they will guide development and block certain avenues.

Belief Systems

Belief systems are there to communicate the vision, mission and values of the business. In so doing, they are communicating what the organisation is trying to achieve and how individuals are to behave, to each other, to customers and suppliers and to society at large.

Belief systems can be very powerful in directing people and giving them purpose. Lots of companies have their values prominently displayed, but getting these values into everyday conversations is much harder to do.

I did a case study in the Nationwide Building Society a few years ago and was a little amused to see flags flying in the foyer spelling out the core values of the organisation. However, these values weren't skin deep, as I talked to the managers about how they managed people in the business, the values kept coming up in the conversations and as I spoke to the employees, the same conversations recurred. People knew what was expected of them, how they were to be treated and how to behave in difficult situations.

Similarly, when I worked for Kingsway Group many years ago, I quickly had to learn what was and wasn't acceptable business conduct. Through discussing business opportunities and potential deals with the chairman and chief executive it rapidly became clear that there was an ethical imperative in all our dealings and certain practices were off limits because they didn't deal fairly with certain stakeholders. When I became a Managing Director of one of the subsidiary companies I continued to communicate those values to the people we took on and it guided what we did and didn't do. One of the strengths of this belief system was that we had a builders merchant only policy, and refused to ever deal directly with builders by going round our agents the builders merchants. The strength of this policy was that it was ingrained in the belief system, so we all knew that no one would break it and our customers knew that too, which cemented a strong relationship.

The Four Levers of Control

The four levers of control are supposed to complement each other. Diagnostic Controls and Boundary Systems are constraining, whilst Interactive Controls and Belief Systems should be designed to guide development and growth. But the hard part is keeping them up to date so that they continue to be relevant and to reflect the strategic direction of the business.

Benefits

Different controls have different roles to play in managing the organisation.

Diagnostic Controls can become very mechanical and even destructive if used the wrong way, having a strong Belief System can mitigate against the worst consequences of overused Diagnostic Controls.

Interactive Controls work well when there is a cohesive senior management team.

Belief Systems work best when senior management really believe in the values of the business, but you can't fake this.

Pitfalls to be avoided

Managing four control systems needs lots of effort and permanent attention from every level of management.

Getting Belief Systems to permeate the business takes time to build and can be destroyed by one bad action or decision.

Boundary Systems can be over constraining, so pay attention to writing these well and reviewing them frequently.

Bibliography

Simons, R. (1995) 'Control in the Age of Empowerment', Harvard Business Review, 73, 2, pp.80-88 - available through the 'Further reading' section below.

Further reading

The ICAEW Library & Information Service provides full text access to leading business, finance and management journals. Further reading on the 'Levers of Control' is available through the articles below.

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The following BPM tool guide is one of a series produced for ICAEW by Professor Mike Bourne of Cranfield University.